Explanatory Memorandum to COM(2017)14 - Macro-financial assistance to Moldova - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2017)14 - Macro-financial assistance to Moldova. |
|---|---|
| source | COM(2017)14  |
| date | 13-01-2017 |
1. CONTEXT OF THE PROPOSAL
• Reasons for and objectives of the proposal
The Republic of Moldova has faced a difficult period over the last two years on both the economic and political fronts. A major banking fraud scandal erupted in November 2014, exposing severe governance problems that have since been accompanied by political instability – including the formation of three different governments since the November 2014 elections and the replacement of the governor of the National Bank of Moldova (NBM) – and street protests. Those developments have also led to a deceleration in economic growth, the suspension of budget support by Moldova’s international partners, and a weakening of the fiscal and balance of payments position. Economic difficulties have been exacerbated by a recession or weak economic activity in some of Moldova´s key regional trading partners (notably Russia, but also Belarus and Ukraine), developments which reduced exports and remittances. This effect has only been partly offset by increased trade with the EU following the entry into force of the Association Agreement signed in 2014, which foresees the creation of a Deep and Comprehensive Free Trade Area (DCFTA).
In that context, Moldova requested support from the International Monetary Fund (IMF). After difficult and protracted negotiations, which reflected the existing political instability, in July 2016 the authorities finally reached agreement with the IMF on a programme to be supported by a three-year Extended Credit Facility and Extended Fund Facility (ECF/EFF) arrangement. The agreement was approved by the IMF Board on 7 November 2016. This agreement was made possible by a new determination on the part of the authorities, following the appointment of a new government led by Prime Minister Filip in January 2016 and of a new central bank governor in March 2016, to address governance problems in the financial sector and in public finance management (PFM). Access under the financial arrangement agreed with the IMF would represent 75% of Moldova’s quota in the IMF (SDR 129.4 million, or about EUR 161 million). The aim of the ECF/EFF is to make swift improvements in financial sector governance and supervision, strengthen policies to ensure macroeconomic and financial stability, and foster sustainable and inclusive growth.
It should be noted that following the Foreign Affairs Council Conclusions of 15 February 2016, a Roadmap for Priority Reforms was agreed between the EU and the Moldovan authorities with the purpose of re-launching key structural reforms; the deadline was set for 31 July 2016. There has since been substantial progress with the implementation of this Roadmap, but as yet not all the EU concerns, expressed in the February Council conclusions, have been addressed.
The Moldovan government also requested Macro-Financial Assistance (MFA) from the EU in August 2015 and reiterated that request in March 2016 1 . As a result of that request and in context of the political and economic developments since 2014, the European Commission is therefore submitting to the European Parliament and the Council a proposal for a Decision providing MFA to the Republic of Moldova of up to EUR 100 million. Of this amount, EUR 60 million would be in the form of loans and EUR 40 million in the form of grants. The proposed amount is justified based on an updated assessment of the country's external financing needs, the size of the IMF programme, burden-sharing considerations, and the room for manoeuvre available in the EU budget.
The proposed EU MFA would help Moldova cover part of its residual external financing needs over the period 2016-2018, which are estimated at USD 442 million (EUR 402 million), in the context of the new IMF programme. The operation would reduce the economy’s short-term balance of payments and fiscal vulnerabilities. It would be designed and implemented in coordination with the adjustment and reform programmes Moldova is agreeing with the IMF and the World Bank, as well as with the reforms agreed in the context of the EU’s budgetary support operations and the DCFTA agreement.
The implementation of the proposed operation is expected to go hand-in-hand with the resumption of disbursements under budgetary support operations financed by the European Neighbourhood Instrument (ENI). They have been frozen since early 2015 reflecting concerns over governance and the lack of a reliable macroeconomic policy strategy.
As further elaborated in the Commission Staff Working Document accompanying this proposal, the Commission considers, based also on the assessment of the political situation made by the European External Action Service, that the political and economic pre-conditions for the proposed MFA operation are satisfied.
• General context
The macroeconomic outlook for Moldova remains vulnerable, but the combination of recent adjustment measures and the prospect of a resumption of foreign donor support have helped the country regain some stability.
After a marked deceleration of growth in 2014, Moldova entered a recession last year, with its GDP decreasing by 0.5% in 2015 due to: (a) adverse weather conditions causing a 13.4% contraction in agricultural output; (b) an accelerating decrease in remittances and weak export performance, reflecting the recession or weak economic activity in some of Moldova's main trading partners, notably Belarus, Russia and Ukraine; c) weak domestic credit expansion following the problems in the banking system and the tightening of monetary policy; and d) a fiscal squeeze partly caused by the suspension of international donors' support, but also by the decline in tax revenues due to the recession, which significantly affected, inter alia, the public investment programme for 2015. After the adjustment in 2015, Moldova’s economy is expected to recover only slowly in 2016 and the coming years. In 2016, GDP is expected to grow by about 2%. Growth in 2016 will continue to be constrained by budget cuts and tight credit conditions as well as by low remittance flows and higher local energy tariffs, which will keep private consumption subdued. Meanwhile, the reorientation towards EU markets will take time and require investment.
After accelerating from 4.7% in December 2014 to 13.5% in December 2015 (year-on-year), consumer price inflation has been on a downward trend, reaching 3.0% in September 2016. The IMF projects average annual inflation at 6.9% for 2016 and 4.9% for 2017.
The government has been experiencing substantial fiscal pressures due to lower budget revenues resulting from weaker economic activity and the interruption of budget support from donors. Those factors contributed to the increase of the budget deficit from 1.9% of GDP in 2014 to 2.3% of GDP in 2015. Consistent with the programme agreed with the IMF, a revised 2016 budget was adopted by the government and signed by the President on 4 October 2016, foreseeing the necessary adjustment measures on both the expenditure and revenue sides so as to meet the 3.2% of GDP deficit target.
Overall, savings made through both revenues and expenditure measures amounted to 2.2 billion lei, or 1.7% of GDP, in 2016. They include measures to control the wage bill (also by cutting vacant positions) as well as various measures to improve tax collections and reform the tax administration and reduce the excessive number of tax exemptions).
The share of the general government debt to GDP increased from 36% at the end of 2014 to 45% at the end of 2015. These estimates take into account the emergency loans with State guarantees issued by the NBM to the three banks under liquidation. Last year's increase in government debt was largely driven by its domestic debt component. External government debt increased less (from 18% of GDP in 2014 to 21% of GDP at the end of 2015) and the increase was mainly attributable to the deprecation of the leu. External debt is mostly medium - and long- term debt owed to multilateral and bilateral creditors on concessional terms.
In 2015, the current account deficit declined to EUR 293 million (by 40% year-on-year), due to a marked drop in prices of imported energy and the weakness of domestic demand, which depressed imports. As a percentage of GDP, however, the current account deficit declined from 6.7% in 2014 to 5.0% in 2015, due to the decrease of GDP in dollar terms in 2015 (itself a reflection of both the drop in real GDP and of the depreciation of the leu).
Despite the turbulent economic and political developments in Moldova, FDI inflows in 2015 have not been affected. In 2015, FDI inflows reached USD 165 million, compared to USD 158 million for 2014. Moldova’s free economic zones were important in attracting FDI.
As a result of the crisis in the financial sector, international reserves declined by 35% between September 2014 and February 2015, to USD 1.7 billion, or about 4.3 months of imports. More specifically, within that period, the NBM sold from its foreign exchange reserves, both in special sales to the three State-controlled banks that went into liquidation and on the foreign exchange market, a total of USD 700 million. That decline partly reflected an increase in the rate of dollarization of savings as confidence in the leu weakened. Since then, reflecting the stabilisation and recovery in the foreign exchange market, the central bank accumulated USD 2.1 billion in foreign reserves by September 2016, which represents an estimated 5.1 months of projected imports.
After several years of stalemate in the reform process, substantial progress has been achieved with the implementation of the structural reform agenda over the last six months, including those reforms that are part of the Priority Reform Action Roadmap agreed with the EU in February 2016. However, there have been delays in adoption of measures in some areas, such as public administration reform, the appointment of the president of the National Commission for Financial Markets (NCFM), as well as steps towards the liberalisation of the electricity and gas sectors. The EU has been increasingly involved in the provision of technical and policy advice to Moldova on structural reforms through the funding of a team of 25 so-called High Level Advisors who work side by side with high level officials in different institutions. The latter include the Prime Minister, the Minister of Finance and the Governor of the NBM. This unprecedented exercise touches upon reform areas as important as financial sector reform, PFM, external audit and the implementation of the DCFTA.
The IMF’s November 2016 projections furthermore point towards significant balance of payments needs for the period 2016-2018, with the total external financing gap estimated at USD 469 million (USD 184 million in 2016, USD 186 million and USD 99 million in 2018). This financing gap can broadly be attributed to three factors: a relatively large current account deficit, the need to build up foreign exchange reserves, and the large debt amortization requirements expected. The proposed new MFA operation of EUR 100 million would cover 24.9% of the estimated residual financing gap (after deducting net IMF financing and the expected disbursement of World Bank policy-based loans).
• Existing provisions in the area of the proposal
Decision No 938/2010/EU providing previous macro-financial assistance to the Republic of Moldova in the amount of EUR 90 million in grants was adopted by the European Parliament and the Council on 20 October 2010 2 . The assistance was fully disbursed during 2010-2012.
• Consistency with the other policies and objectives of the Union policies
The European Union and the Republic of Moldova have developed a close political and economic relationship over the years. It has led to the conclusion of an Association Agreement, including a DCFTA, which was signed on 27 June 2014 and entered fully into force on 1 July 2016. The Association Agreement replaced the previous Partnership and Cooperation Agreement and will allow for the political association and economic integration of Moldova with the EU. An Association Agenda – approved in 2014 – sets out a list of priorities for joint work in the 2014-16 period, based on the structure of the Association Agreement. It is currently under review in order to produce an updated version for 2017-2019. The Single Support Framework for 2014-2017 identifies the priority sectors of EU cooperation with Moldova under the European Neighbourhood Instrument. Work has also started to produce a new Single Support Framework for 2017-2020.
Moldova's economic ties with the EU are also well developed. In 2015, the EU was Moldova's largest trading partner, with a trading share of 53%, well in front of Russia with 13%. In 2016, that share has further risen to 62%.
Countries that are covered by the European Neighbourhood Policy are eligible for MFA. The EU MFA would complement the grants mobilised under the ENI and other EU programmes and in particular the conditionalities envisaged under the budget support packages being implemented by the EU. By supporting the adoption, by the Moldovan authorities, of an appropriate framework for macroeconomic policy and structural reforms, the EU’s MFA would enhance the added value and effectiveness of the EU’s overall financial interventions, including through other financial instruments.
While Moldova still faces concerns regarding its human rights record as well as governance and rule of law issues, the Moldovan authorities are demonstrating a renewed commitment to addressing the country's governance challenges and to moving forward with the necessary political reforms. However, delivering on key reforms remains indispensable for a successful implementation of the MFA and will be monitored closely.
In that context, Moldova is deemed to to meet the political preconditions for the granting of MFA to third countries, notably in terms of respect for democracy, human rights and the rule of law, and it is a country with which the EU maintains close political and economic relations. A detailed assessment of the satisfaction of these political criteria for MFA produced by the European External Action Service is annexed to the Commission Staff Working Document accompanying the proposal.
2. LEGAL BASIS, SUBSIDIARITY AND PROPORTIONALITY
• Summary of the proposed action
The MFA operation under consideration would amount to a maximum of EUR 100 million. The Commission proposes to provide the amount of the assistance in the form of a medium-term loan of up to EUR 60 million and in grants of up to EUR 40 million. The assistance will contribute to cover Moldova's residual external financing needs in 2016-18, as identified by the Commission based on the estimates of the IMF.
Given the proposed size of the operation, the Commission is considering releasing the assistance in three instalments. The first two instalments, composed each of a grant element of EUR 10 million and a loan part of EUR 20 million, would be disbursed in 2017; the third one, composed of a grant element of EUR 20 million and a loan part of EUR 20 million, in the first half of 2018. The assistance will be managed by the Commission. Specific provisions on the prevention of fraud and other irregularities, consistent with the Financial Regulation, are applicable.
Strict conditions will be attached to the disbursements under the MFA, with each tranche, including the first one, conditional on good progress with both the IMF programme and the specific policy conditionality agreed with the EU in the Memorandum of Understanding attached to this operation. These policy conditions should address some of the fundamental weaknesses shown over the years by the Moldovan economy and economic governance system. Possible areas of conditionality could include reforms to strengthen governance in the financial sector, PFM, energy sector reform, and accompanying measures to strengthen the social safety net, improving the investment climate and supporting the implementation of the DCFTA agreement.
The decision to disburse the proposed assistance in grants and in loans is justified by Moldova’s level of development (as measured by the country’s per-capita income) and debt indicators. It is also consistent with the treatment given to Moldova by the IMF and the World Bank. Indeed, Moldova is eligible for concessional financing from both the IMF's Poverty Reduction and Growth Trust and the World Bank’s International Development Association (IDA).
• Legal basis
The legal basis for this proposal is Article 212 TFEU.
• Subsidiarity (for non-exclusive competence)
The subsidiarity principle is respected as the objectives of restoring short-term macroeconomic stability in the Republic of Moldova cannot be sufficiently achieved by the Member States alone and can be better achieved by the European Union. The main reasons are the budgetary constraints faced at the national level and the need for strong donor coordination in order to maximise the scale and effectivenes of the assistance.
• Proportionality
The proposal complies with the proportionality principle: it confines itself to the minimum required in order to achieve the objectives of short-term macroeconomic stability and does not go beyond what is necessary for that purpose.
As identified by the Commission based on the estimates of the IMF in the context of the Extended Fund Facility, the amount of the proposed new MFA corresponds to 24.9% of the estimated residual financing gap for the period 2016-2018. This is consistent with standard practices on burden-sharing for MFA operations, taking into account the assistance pledged to Moldova by other bilateral and multilateral donors.
• Choice of the instrument
Project finance or technical assistance would not be suitable or sufficient to address the macroeconomic objectives. The key value added of the MFA in comparison to other EU instruments would be to alleviate the external financial constraints and to help create a stable macroeconomic framework, including by promoting a sustainable balance of payments and budgetary situation, and an appropriate framework for structural reforms. By helping to put in place an appropriate overall policy framework, MFA can increase the effectiveness of the actions financed in Moldova under other, more narrowly-focused EU financial instruments.
3. RESULTS OF EX-POST EVALUATIONS, STAKEHOLDER CONSULTATIONS AND IMPACT ASSESSMENTS
• Consultation of interested parties
MFA is provided as an integral part of the international support for the economic stabilisation of the Republic of Moldova. In the preparation of this proposal for MFA, the Commission services have consulted with the IMF and the World Bank, which have already put in place sizeable financing programmes and are preparing new ones. The Commission consulted the Economic and Financial Committee on 20 September 2016, where an endorsement for the draft proposal was provided. The Commission has also been in regular contact with the Moldovan authorities.
• Collection and use of expertise
In line with the requirements of the Financial Regulation, the Commission services have carried out an Operational Assessment of the financial and administrative circuits of Moldova to ascertain that the procedures in place for the management of programme assistance, including MFA, provide adequate guarantees. They received the final report of the Operational Assessment, prepared by a consultancy company in February 2016. The report concludes that the current status of the administrative and financial circuits of Moldova is broadly adequate for managing a new MFA operation although important weaknesses remain. Developments in that area will continue to be closely monitored also through the regular progress reports on PFM reforms produced by the EU Delegation in Chisinau.
• Impact Assessment
The EUs macro-financial assistance is an exceptional emergency instrument aimed at addressing severere balance-of-payment difficulties in third countries. Therefore, this MFA proposal is exempted from the requirement to carry out an Impact Assessment in accordance with the Commission's Better Regulation Guidelines (SWD(2015) 111 final) as there is a political imperative to move ahead quickly in this emergency situation requiring a rapid response.
More generally, the Commission's MFA proposals build on lessons learned from ex-post evaluations carried out on past operations in the EU's neighbourhood. The new MFA and the economic adjustment and reform programme attached to it will help alleviate Moldova's short-term financing needs while supporting policy measures aimed at strengthening medium-term balance of payments and fiscal sustainability and raising sustainable growth, thus complementing the programme to be agreed with the IMF. These policy conditions should address some of the fundamental weaknesses shown over the years by the Moldovan economy and economic governance system. Possible areas of conditionality could, in principle, include reforms to strengthen governance in the financial sector, PFM, energy sector reform, and accompanying measures to strengthen the social safety net, improving the investment climate and supporting the implementation of the DCFTA agreement.
4. BUDGETARY IMPLICATIONS
The planned assistance would be provided in the form of a loan and a grant. The loan would be financed through a borrowing operation that the Commission will conduct on behalf of the EU. The budgetary impact of the loan assistance will correspond to the provisioning of the EU's Guarantee Fund for external actions, at a rate of 9% of the amounts disbursed, from budget line 01 03 06 ("Provisioning of the Guarantee Fund"). Assuming that the first two loan disbursements (of EUR 20 million each) will be made in 2017 and the third loan disbursement (of EUR 20 million) in 2018, the provisioning will take place, in accordance with the rules governing the guarantee fund mechanism, in the 2019-20 budgets, for an amount of EUR 3.6 million and EUR 1.8 million, respectively. 3 The grant element of the assistance (EUR 10 million each for the first two tranches and EUR 20 million for the third tranche) would be financed from commitment appropriations of the 2017 and 2018 budget, under the budget line 01 03 02 (Macro-financial assistance), with payments taking place in 2017 and 2018. Based on current projections on the utilisation of the budget line 01 03 02 and 01 03 06, the Commission assesses that the budgetary impact of the operation can be accommodated.
5. OTHER ELEMENTS
• Review/revision/sunset clause
The proposal includes a sunset clause. The proposed MFA would be made available for two and a half years, starting from the first day after the entry into force of the Memorandum of Understanding.